Something I bought at Heathrow Airport

I sometimes pick up quick-to-read paperbacks, either fiction or non-fiction, at airports to help pass the time during my flight. So, on a recent short break to Malta, I bought Dambisa Moyo’s How the West Was Lost, published a short while ago, which seeks to argue that for various reasons, good and bad, the West (essentially, Western Europe and North America) is in danger of losing out to the East. I was intrigued enough to pay a few quid for the book, but in the end I should have known better.

Moyo has a lot of things to say with which free marketeers might approve of: she denounces the way in which the banking system has encouraged over-use of debt financing, creating all manner of problems, culminating in the sub-prime mortgage disaster and associated asset price bubble; she also understands that modern Welfare States have created many problems. However, for all that she tries to accept that the rise of the former Third World nations from poverty is a Good Thing and to be applauded, I cannot help but feel that she does not really mean it very much. She’s a mercantilist who sees economics as a titanic fight between states and is hostile, or at least sceptical, about the capacity of people operating in markets under the rule of law. And she repeats the canard that the panic of 2008 demonstrated the dangers of unfettered capitalism, oblivious to the fact that the monetary policies of the Fed, etc, were policies of state institutions, as was the interference in the US and other housing markets by governments (Freddie Mac, etc).

In fact, she seems wedded to a sort of neo-Malthusian argument that says that the desire for prosperity and higher living standards in places such as China is unmitigated bad news for the West as there are finite resources in energy, etc, and that Eastern prosperity comes at the expense of the West’s. In other words, she is arguing that economics is, in some ways, a case of winners and losers. Indeed, she talks repeatedly about the idea of there being a race, often using the very word… “race”… to make her points.

Here is one typical paragraph in which she says the West is suffering from all that terrible selfish individualism and we should benefit from a bit more of that no-nonsense collectivism as seen in China (page 172):

“Frankly speaking, the constitutional framework that has defined the US for the past three centuries is not likely to be amended in order to hand over more power to the state. Yet arguably more power, more flexibility and fewer committees are exactly what is needed. What sense does it make in the depths of the financial crisis – a state of economic emergency by most accounts, which brought the country and the world to its knees – for the President of the United States to have to build consensus around a desperately needed fiscal stimulus package before he and his advisors can act?”

She seems curiously unaware of to what extent the powers of the Federal government in the US have already gone way beyond what was envisaged by the Founders – and that’s a bad thing – and that in other Western nations, such as the UK, the government of the day has considerable powers, or has yielded great powers to the European Union and its legions of unelected officials. And yet for Ms Moyo the problem is that is far too much of this pesky liberalism, checks and balances, and so forth. I hate to say it, but she’s coming close to flirting with a form of fascism.

There are other, equally poor, arguments. For instance, she argues that the vast majority of citizens in Western nations have only reaped a small share of the benefits of greater trade and so on because many of the profits earned are paid to shareholders. For instance: (page 178) “The only thing companies were interested in was the company’s profitability and therefore the shareholders’ return on capital.”

Wow, the owners of firms want to make a profit (as opposed to making a whacking great loss, presumably). But even this line ignores the fact that by “shareholder”, we do not just mean a few isolated fat, capitalist bastards in suits; no, we also mean all the millions of people – including people a bit like Ms Moyo – who have savings plans, 401K plans, mutual funds, pension pots, etc. This line of hers also does rather beg the question of what should happen to these profits – should they be taxed in “reinvested” by governments? In several instances, she praises the behaviour of governments, such as oil-rich states, and their massive “sovereign wealth funds”, arguing that these are used to benefit domestic populations. Well they may be in some cases, but even a cursory awareness of public choice economics should alert Ms Moyo to the dangers of corruption, mis-allocation of capital, political favouritism and faddism that often comes when government agencies disburse vast sums. The flashy public spending projects of the past have often brought dubious rewards.

And I just knew I had wasted my aircraft reading time when she scorned Ricardo’s Law of Comparative Advantage, arguing that unless all countries play “fair” (which never happens), then the argument for free trade that the LCA underpins is chucked away.

This argument – that free trade is only beneficial if everyone plays nice – has been demolished time and again. A good example comes from Deepak Lal, in his book, Reviving the Invisible Hand.

Here is a passage:

“a country will benefit from removing its own tariffs and import restrictions even if all its trading partners maintain theirs. For as long as the domestic prices of goods in our country under autarky differ from those at which they can be imported and exported under free trade, the country will be able to obtain the gains from trade both by obtaining imported goods at a lower cost than they are produced at home (the consumption gain) and by specialising in producing and exporting those goods in which it has a comparative advantage and importing the others (the production gain), irrespective of the tariff applied by their trading partners. For these trade restrictions only damage the protectionist country’s welfare, and it would be senseless not to improve one’s own welfare just because someone else is damaging theirs. There is no point throwing rocks into one’s harbour just because others are throwing rocks into theirs. Hence, there is an incontrovertible case for every country to unilaterally adopt free trade, irrespective of the protectionist policies of other countries – with one exception. Suppose that a country is the only producer of some good – say, oil.”

He goes on to explain this case but says that in fact, retaliatory trade practices and other issues take the edge off this argument also.

It is all such a pity. She started well, but I really wish I had read that new Lee Child thriller instead.

February 8th, 2011 |

39 comments to Something I bought at Heathrow Airport

One of the things I most like about blogging is that when you do find yourself stuck with some kind of turkey, such as a horrible performance or movie or some such, or in your case just the one book on a journey, you can rescue the time you would otherwise have wasted by doing a blog posting about it, and in the meantime thinking about that blog posting. I’m guessing you actually quite enjoyed reading this book, but only because you are a Samizdatista. Even as you read it, you were consoling yourself with the thought of the demolition job you would shortly be giving us all.

Criticising the Law of Comparative Advantage as Ricardo applied it to trade is reasonable. Ricardo assumed that capital is immobile, but in reality it isn’t. Which brings us to a more complicated argument involving both comparative and absolute advantage.

None of this really harms the case for free markets. But it does mean that they don’t necessarily raise the living standard of every country, though they do raise the living standard of the world.

Current, not sure whether that is entirely correct. Even when Ricardo was writing, back in the early 19th, there was some capital movement, although obviously not as great as say, in the decade prior to WW1 or the last few years. It would be odd to state that the Law of Comparative Advantage as he set it out does not involve any capital movement whatever.

I think it is pretty clear that where barriers to trade are lifted, countries freed from such tariffs see benefits to the domestic populations, such as cheaper imports, and so on.

Indeed, the argument from the likes of Moyo seems to be that people living in countries enjoying greater capital movement are almost hermetically sealed off from the widening wealth that gets created from the mutual benefits of all this trade.

I cannot recall being more disappointed in a book that promised to be sensible. Oh well.

Yes, there was discussion of capital and labour movement in Ricardo’s time. But, the law of comparative advantage depends upon it not being very important.

As late as the beginning of the nineteenth century people could scarcely suspect the significance of this problem. Ricardo’s theory of foreign trade still started with the assumption that the free mobility of capital and labor exists only within the boundaries of a country. In the home country all local differences in the profit rate and the wage rate are evened out by movements of capital and workers. Not so for differences between several countries. Lacking there was that free mobility which would ultimately be bound to cause capital and labor to flow from the country offering less favorable conditions of production to the country of more favorable conditions. A range of emotional factors (“which I should be sorry to see weakened,” the patriot and politician Ricardo interjects here into the exposition of the theorist) resists that. Capital and workers remain in the country, even though they thereby suffer a loss of income, and turn to those branches of production having, while not absolutely, still relatively more favorable conditions.34 The basis of the free-trade theory is thus the fact that noneconomic reasons keep capital and labor from moving across national boundaries, even if this seems advantageous for economic motives. This may have been true on the whole in the days of Ricardo, but for a long time it has no longer been true.

I’m not sure if you meant something a bit different by what you’ve written below:

Indeed, the argument from the likes of Moyo seems to be that people living in countries enjoying greater capital movement are almost hermetically sealed off from the widening wealth that gets created from the mutual benefits of all this trade.

But, this is quite right, and the right argument for free trade. Since today capital is relatively mobile but labour isn’t that means that capital will migrate to where it’s yield is the highest. That could mean (though it need not) that the west will be decapitalised relative to the east. (This is called the Balsa-Samuelson effect, though as Samuelson acknowledged many others thought of it before).

The issue here is that rich countries may be able to retain their capital through tariffs, but that won’t help in the long run. In the long run the world economy will grow in productivity more greatly than countries that are isolated because it will benefit the most from worldwide division of labour and from technology.

Regarding comparative advantage, I found the following discussion interesting. It’s from 1955, when America and Japan were negotiating their first post-occupation trade agreement. The head of the American delegation, C. Thayer White, told the Japanese to cut their tariff on imported cars, because:

1) America’s car industry was the largest and most competitive in the world.

2) American car manufacturers were strongly in favour of expanding their opportunities for world trade.

3) Their access to foreign markets had been harmed by import controls.

4) Although the US government appreciated that countries may want to impose import controls for balance of payment reasons…It would be in Japan’s interest to import automobiles from America, and export items in which Japan could excel.

To which the Japanese trade negotiator, Kenichi Otabe, replied:

1) If the theory of international trade was pursued to its ultimate conclusion, the United States would specialise in the production of automobiles and Japan in the production of tuna.

2) Such a division of labour does not take place…because each government encourages and protects those industries which it believes important for reasons of national policy.

The Japanese correctly understood that economic growth is path dependent, and reliant on “good” industries. I’m not sure that Ricardo’s theory is the best prism within which to view these crucial aspects of economic development.

1) If the theory of international trade was pursued to its ultimate conclusion, the United States would specialise in the production of automobiles and Japan in the production of tuna.

Firstly… would this actually be bad?

Secondly… given how dynamic economies are, even if this is true (and that is debatable) would this remain true for long? Notions of economic equilibrium and end-state are usually either questionable or transient or both

I find it interesting how few people realise that Big Corporations’ profits often benefit us all.

One of the odd things arising from the BP oil spill was the startled realisation in our media that most of us actually rely on BP’s dividends in our pensions and investments, so large-scale losses actually affect us as well as Fat Cats and Greedy Bankers.

Perhaps not in terms of the efficient allocation of global resources in 1955. But yes, taking the comparative-advantage tuna fishing option would have been worse for Japanese wealth and development in the long run.

Secondly… given how dynamic economies are, even if this is true (and that is debatable) would this remain true for long? Notions of economic equilibrium and end-state are usually either questionable or transient or both

Fishing obviously had fewer opportunities for lucrative new development paths than the automotive industry did 56 years ago.

Fishing obviously had fewer opportunities for lucrative new development paths than the automotive industry did 56 years ago.

I think you rather miss the point… that was not and likely never would have been the actually outcome or indeed the ‘choice’ on offer… even if the state has not been involved at all it is highly unlikely that USA would have just specialised in cars and Japan in Tuna.

The whole notion posited by Kenichi Otabe was bogus because not everyone with capital in Japan would feel it was best invested in Tuna or nor everyone with capital in the USA in cars for reasons that should be obvious unless technology suddenly returns to medieval rates of advancement 🙂

Perry, I agree with you. But thank goodness they didn’t otherwise we’d all still be driving some very shitty automobiles. It’s quite clearly a free market signal that unionisation and stagnation are bad things.

What sense does it make in the depths of the financial crisis – a state of economic emergency by most accounts, which brought the country and the world to its knees – for the President of the United States to have to build consensus around a desperately needed fiscal stimulus package before he and his advisors can actdo something completely stupid and corrupt?

Fixed it for her.

There’s a presumption on her part that somehow the President is going to be competent, rather than corrupt and busy lining the pockets of his supporters (and donors). I don’t know what fantasy land she lives in.

I use the anecdote, as did Kenichi Otabe, to show that comparative advantage can mean specialising in things with poor long-run development potential. Obviously Japan wouldn’t have just fished tuna under free trade, anymore than the US would have just flogged cars. I don’t think that free trade was the optimal choice for postwar Japan, as the things they had comparative advantage in — agriculture and cheap manufacturing — had fewer known and unknown positive externalities than more sophisticated manufacturing. Japanese politicians understood that externality benefits from protected, sophisticated industries outweighed the costs to Japanese consumers of protectionism.

James, firstly, I think you should replace “understood” with believed. Secondly, the two are not mutually exclusive. The Japanese car industry may have been quite successful even without the protectionism (particularly with the doldrums the US car industry was beginning to slide into). Also, who is to tell what other sophisticated industries may have arisen from a non-protectionist Japanese free market?

James is still in thrall to the allure of mercantilism. It’s an unsophisticated philosophy, superficially reasonable yet supportive of increased governmental power, which explains its continued appeal to politicians notwithstanding having been completely discredited (economically) in the 19th century. I would have expected better here, though.

I use the anecdote, as did Kenichi Otabe, to show that comparative advantage can mean specialising in things with poor long-run development potential.

The point others are making here is that this is really an argument for central planning. What Kenichi Otabe is saying is that if he allows those Japanese who own capital to make their own choices about how to invest it then they will make poorer decisions than if they are led to the right choice by the state.

Japanese politicians understood that externality benefits from protected, sophisticated industries outweighed the costs to Japanese consumers of protectionism.

As Richard says above, they believed this to be the case. Perhaps they were right. Many other developing countries have gambled on similar ideas, and they are still “developing” now. I think it’s more likely that Japan’s success stems from it’s culture rather than it’s industrial policies.

I have heard of the externality argument for protectionism before. To a limited degree it’s correct, but only in a dynamic situation where the government have more local knowledge than those on the ground.

I work in a “high-tech” industry myself, in silicon chip design. I was perfectly aware when I joined that industry that I would learn from it and it would enhance my human capital allowing me to sell my labour for more later. I accounted for the positive externalities, as I expect did all my colleagues. The state could only have aided me if I had not known about this and they had.

To a limited degree it’s correct, but only in a dynamic situation where the government have more local knowledge than those on the ground.

With regards government support for specific industries and companies, I agree; though I don’t discount the possibility that governments can “pick winners”. But a flat tariff on imports doesn’t require superior government knowledge in order to promote beneficial externalities and scale economies in protected industries.

“But a flat tariff on imports doesn’t require superior government knowledge in order to promote beneficial externalities and scale economies in protected industries.”

Yes it does James, think about it.

Suppose we have an isolated country. What would happen if we cut that country into two equal halves and applied a flat tariff for goods travelling between those two halves? Would both halves benefit from better economic growth? If so how on earth would that happen?

Would each half benefit from greater scale economies and from positive externalities? Would each half benefit more than the whole would have done if the split hadn’t taken place?

With regards government support for specific industries and companies, I agree; though I don’t discount the possibility that governments can “pick winners”.

Expecting governments – which are, after all, recipients of money seized by force – to “pick winners” more effectively than those operating under some sort of self interest, and with their own money, is too ludicrous to require extensive demolition. The history of the last 100 years or more is littered with attempts by governments of various political hues to “pick winners”; in Britain, such attempts ended in failure.

As for Japan, its ascent was remarkable, but that is also a country with the dubious honour of having been in near permanent recession for the last 20 years.

Suppose we have an isolated country. What would happen if we cut that country into two equal halves and applied a flat tariff for goods travelling between those two halves? Would both halves benefit from better economic growth? If so how on earth would that happen?

Would each half benefit from greater scale economies and from positive externalities? Would each half benefit more than the whole would have done if the split hadn’t taken place?

The two halves would become more self-sufficient. This isn’t necessarily a bad thing, just as trade within countries isn’t always good; ask the American South how not being self-sufficient in 1860 worked out for them.

Expecting governments – which are, after all, recipients of money seized by force – to “pick winners” more effectively than those operating under some sort of self interest, and with their own money, is too ludicrous to require extensive demolition.

I didn’t say that governments should pick winners. I just observe that sometimes they have done so. LG, Hyundai and POSCO are South Korean examples of this (and they certainly haven’t been in recession for the last two decades).

“The two halves would become more self-sufficient. This isn’t necessarily a bad thing, just as trade within countries isn’t always good; ask the American South how not being self-sufficient in 1860 worked out for them. ”

But, with a smaller market at each side of the dividing line competition would be much less efficient, that’s absolute advantage.

And that is the problem, all competition is a positive externality. Other positive externalities may be greater certainly, but that’s a matter of historical fact it doesn’t happen by implication from an economic theory. So, in any situation when someone claims “X will benefit from positive externalities” the question must be asked “will they benefit more from those positive externalities than from those already there?”

Also, having worked in South Korea for quite a while I;m doubtful that the industrial policies have much effect. I think the cultural situation is much more important.

But, with a smaller market at each side of the dividing line competition would be much less efficient, that’s absolute advantage.

Sure. Absolute advantage operates within countries, because we don’t care if productive capacity is split unevenly within our borders. The people of York didn’t care that Royal Navy ships were built in Deptford. But they would have cared if Royal Navy ships were being built in Paris or Madrid, even if Paris or Madrid could build the ships in a more cost-effective manner than Deptford.

If you’re a believer in globalism, free trade makes perfect sense all the time. Which is why Karl Marx supported it.

You presented two arguments, firstly the absolute advantage/capital export argument which is sometimes called the Balsa-Samuelson effect. Secondly the positive-externalities argument.

These are quite separate and have different consequences. The absolute advantage/capital export argument is really about distribution of wealth among countries and classes within those countries. It shows that if there is free trade that may not benefit the working classes of developed nations. But, the working classes of developing nations will benefit. All of this is in the medium term, because in the long term growth and division of labour are important. It should be noted too that reducing the income earned by capital makes those who own it more likely to spend it on consumption rather than invest it.

The positive externalities argument is different. If high-tech has positive externalities then that benefits everyone. Its really an argument for subsidy not for a tariff. In that case a tarriff is just an imperfect way of implementing a subsidy.

To be honest I’m sceptical about the real-world implications of both of these ideas. I don’t think the government can clearly see these positive externalities faster than the market. I think that the global market being what it is restricting international capital movement is counterproductive in the long run.

Sometimes, perhaps. But over the last 30 years of increasing free trade, the income gap between the poorest nations and the richest has grown. And the productivity of modern industry is that much greater than peasant agriculture, so it raises average income even if it’s not globally competitive. This is why countries like Mongolia and Peru had higher average incomes before free trade was introduced in the 1990s.

If high-tech has positive externalities then that benefits everyone. Its really an argument for subsidy not for a tariff.

A benefit of a flat tariff on all imports being that it avoids messy arguments about which industries deserve subsidies.

I think that the global market being what it is restricting international capital movement is counterproductive in the long run.

Counterproductive to absolute global wealth, but not necessarily counterproductive to national wealth. If you support globalism, free trade makes perfect sense. Which is why Marx supported it.

To be clear… If absolute advantage is the strongest force then the working classes of developing nations will benefit. That is, the anti-free-trade lobby argue that absolute advantage is the relevant force when lobbying for industry in developed countries to be protected from developing countries. My point here is that were they right about that threat they would merely be impoverishing those developing nations. But, they are wrong about that because the developed world has reasonable government, human capital and most of all different culture.

A benefit of a flat tariff on all imports being that it avoids messy arguments about which industries deserve subsidies.

Yes.

Counterproductive to absolute global wealth, but not necessarily counterproductive to national wealth. If you support globalism, free trade makes perfect sense. Which is why Marx supported it.

Yes, and I’d agree with him about that. Notice though that it’s very difficult to defend the opposite from a tribalistic perspective.

If person X believes that his race is superior then why should he worry about opening up to free-trade and capital movement? If he’s right then it will benefit him and he has nothing to fear from inferior peoples.

So there are – but I do not want to be in a room where a bunch of leftists are on the front covers of books (just seeing “Uncle Vince” Cable on the front cover of a book at a airport bookstore was bad enough to make me feel sick- before I got on the flight).

British bookshops push horrible books – they shove them in the face of anyone who goes into the store, or even passes it on the street.

A benefit of a flat tariff on all imports being that it avoids messy arguments about which industries deserve subsidies.

Yes.

I was a bit too quick to agree there. Although it avoids arguments it doesn’t avoid bias. If a nation tariffs imports then it will not evenly spread the cost of development of industries with positive externalities. The cost will be borne disproportionately by marginal export industries.

To be clear… If absolute advantage is the strongest force then the working classes of developing nations will benefit.

But this isn’t always the case, as my previous examples (and others I could cite) show. In the short term, some working class folk in some developing nations will benefit. But many will lose out in the long run if they are employed in primitive trades with few opportunities for development. This comes back to my first point in my first reply to Perry earlier in this thread.

Which are you arguing for? Are you saying that the developed world is under threat from the developing world, and that the working-classes of the developed world should be protected by capital-controls or tariffs from the effect of absolute advantage. Or, are you saying that the developing world is under threat from the developed world with it’s better institutions, culture and stability, it’s comparative advantage?

If it’s the former, then fair enough, absolute advantage benefits the developing world. Since I’m what you call a “globalist” I don’t care, that provides wealth for those who need it most.

If you’re arguing the latter then that’s inconsistent with your other arguments.

Are you bemoaning the effects of comparative advantage or absolute advantage?

I don’t see how pointing out the negative effects of free trade on the developing world is inconsistent with any of my previous arguments. My original comment was after all about how a developing country (1950s Japan) was, in my view, right to ignore free trade with America on the basis of comparative advantage. Developed countries have nothing to fear from free trade with the poorest nations, for reasons that should be obvious.

But developed countries do have something to fear from free trade with other wealthy nations. They also have reason to be wary of free trade with countries like China and India, which although largely poor and agrarian, also have developed areas that are home to sophisticated industries that we might want to compete in.

James, I read through your other comments again and I think I understand your point of view now.

I think what you don’t understand is that the government has to “pick winners”. A flat tariff on imports isn’t a subsidy to *all* businesses within a country, nor is it a subsidy on positive externalities. It has an uneven effect which harms some industries and benefits others.

Incidentally, are you getting this from a book? If you are then which book?

Free Trade Doesn’t Work by Ian Fletcher (2010) is the source of my first quotes, though Fletcher — an American — looks at the issue primarily from a first world perspective. He makes the case for an American flat tariff and why the US government doesn’t have to pick winners to create successful protectionism.

Although I haven’t read any of his books, I think the South Korean economist Ha-Joon Chang is probably a better source if you want arguments for developing nations to reject free trade.

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